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The Deal Fix

Rate Hikes Cometh: Is Now the Time to Borrow to Finance a Business Acquisition?

By July 8, 2021July 15th, 2021No Comments

Since the beginning of the COVID-19 pandemic, the U.S. economy has been on a rollercoaster. The ride started with a stock market tumble in March 2020, followed by a massive bull run that lasted nearly the rest of the year. The gains have continued halfway through 2021 with U.S. stocks experiencing a fifth-straight quarterly gain. But, as federal bond rates rise and indications of a crash or correction are on the horizon, rising prices also have the attention of economists, business owners and consumers.

Whether the current inflationary pressure is a result of a stressed supply chain or an overstimulated economy (or both), the Federal Reserve is taking note. This week, the board released its most recent meeting minutes and reaffirmed its intention to raise interest rates beginning in 2023 (though the Street is anticipating a hike as early as 2022). Though the increase won’t be sharp, it will have a noticeable impact. So, with the probability of higher borrowing rates on the horizon, potential borrowers may be wondering if now is the time to take advantage of favorable credit conditions to finance the purchase of a business.

Why it’s a Good Time to Borrow, Especially for Businesses

Whether you’re purchasing real estate, an automobile or other assets, there are several advantages to borrowing money when rates are low. Let’s start with the obvious. Securing a lower interest rate translates into lower monthly payments. Lower loan payments are essential when you take ownership of a new company when unexpected expenditures are likely to occur. Additionally, you can use the savings for investments that will appreciate and yield greater purchasing power should rates rise.

Lower rates have additional benefits for a company. If you are considering buying or starting a business, low rates can help finance the purchase of another income stream at a relative discount. Besides funding the purchase, borrowing at cheaper rates enables you to take on a little more risk. For example, you can upgrade your business equipment or building, hire more employees, put more capital into marketing and outreach campaigns, or make acquisitions with less fear of being over-leveraged. Rates will not stay low forever, and the current environment provides an excellent opportunity to invest in your business through the purchase of a new business. Additionally, rising rates in 2022-2023 may make borrowing too expensive for some business owners.

Finding Cost-Savings in a Seller’s Market

Due to the flurry of middle-market M&A activity, buyers are contending with record-high valuations and finding a deal can be a challenge. Managing your own costs is key. Of course, cash is king, but taking advantage of low rates to hold on to cash reserves for a rainy day or another investment opportunity may be a strategy that could soon evaporate. How long will the current seller’s market last? It’s hard to predict. While cycles usually last five to seven years, the current run has already extended longer than previous cycles.

Your Competitors are Investing Now

Prior to the pandemic, and accelerated during the economic shutdown, well-positioned businesses took the opportunity to move on their competition. A recent Brookings essay outlined the macro implications of larger businesses crushing their competition, and the reality should not be ignored by small- and middle-market business owners:

The economic crisis arising from the pandemic is changing the business landscape and exacerbating prior concerns about the state of competition in the U.S. economy. Many firms are struggling financially, have filed for bankruptcy, or have shut down. But some large, well-positioned firms appear to have increased their market share, accelerating trends seen prior to the pandemic. Other firms are increasing cash reserves, ready to acquire competitors who are being damaged by revenue declines, excess leverage, and financial distress. With COVID-19 disruptions likely to reinforce the dominance of the largest firms in the economy, increase bankruptcies, and reduce new business entry today, tomorrow’s product and labor markets may be less competitive and less productive than they were before the crisis.

The pandemic, paired with favorable financial conditions (access to cash reserves and cheap money), gave prepared companies (private and public) a once-in-a-generation opportunity to accelerate the growth of their companies. These conditions persist and are being exploited by companies that recognize the time to buy is now.

What Lenders Will Require

If you choose to finance your acquisition, potential lenders will consider several things when assessing your fitness to borrow and the value of the target asset:

Finances of current business and personal credit history:

– Business credit score (if you already own a business)
– Personal credit score (if first-time business purchase)
– Tax returns
– Cash flow statement
– Outstanding debts

Finances of acquired business:
– Balance sheet
– Business tax returns
– Profit margin
– Valuation

So . . . Should You Borrow Now to Buy a Business?

In general, yes. While securing a loan to finance the purchase of a business may take a bit longer than a cash offer, low rates make this option very attractive. If you are considering acquiring a business, and with news of possible rate increases on the horizon, now is a pretty good time to borrow in order to grow.

Michael Callam is president of Gertsburg Licata’s Talent and M&A advisory groups. He can be reached at [email protected] or (216) 573-6000 x7003.

Gertsburg Licata is a full-service, strategic growth advisory firm focusing on business transactions and litigation, M&A and executive talent solutions for start-up and middle-market enterprises. It is also the home of CoverMySix®, a unique, anti-litigation audit developed specifically for growing and middle-market companies. 

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